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Arthur Wood – A Clauswitzian Interpretation Of Impact Investing

July 24th, 2012

Avatar_86Arthur Wood is the Einstein of social finance. You may not immediately understand everything he says, writes or does but you know he is worth paying attention to.

For example, several years ago on a whiteboard in Vancouver he sketched out the basic concept of what would become Social Impact Bonds. None of us realized the significance of the conceptual leap he was making.

In this excerpt from my What Are You Skating Towards series, Arthur makes the case for a strategic partnership between philanthropic dollars and private pools of capital to tackle our tough social and environmental challenges. This combination of social and financial return is more and more referred to as Impact Investing. Click here to read the full essay or Download What Am I Skating Towards?

… Impact investing and philanthropy now need to think about the synergistic engagements it wishes to use to defeat our pressing social challenges. We can no longer continue raising money without a strategic vision or continue throwing silver bullets at the huge social problems we face – no matter how well crafted the silver bullet. We need to think how we create systemic collaboration to fire the bullets so they land on the target and create definable and ‘audit able’ impact.

Pragmatically we do not have the resources in the current paradigm (philanthropic). To put it in context the Gates Foundation total endowment is about what the Pentagon spends in a month. Another example, Total Global Foundation funding is about $50 Billion versus the challenge of Sanitation at $550 Billion per annum or the Climate change challenge where the damage is estimated at $5.3 trillion.

In addition we have created in the current for profit / not for profit paradigm, incentives to fragmentation

Former President Clinton has noted we have for the most part created the solutions – the challenge is now in scaling them.

It is here that the current paradigm fails in delivery. For example, since 1973 in the US less than 0.007% of not for profits have reached $50 million in revenues or more. If we are to move the models to scale we cannot continue building inside our sectoral silos. We need to consider new forms of collaborations (For profit / not for profit/ community) focused and incentivized on the delivery of tangible outcomes.

This debate is being driven as well by a realization that money has dried up and that new partnerships utilizing modern commercial techniques are required.
The opportunities of applying new financing techniques in collaboration with the commercial sector are potentially measured in billion if not trillions that could be applied to funding social goods. Here are six financial opportunities by pursuing new social entrepreneurial innovations:

  1. The move from Grant Investment to more Program Related Investment (PRI) ($50 Billion). Currently only about 1 -2 % of Foundation funding is in Program Related Investment.
  2. The move to more Mission Related Investment (MRI)($1 Trillion core funds). Again only about 1 -2% of funds are currently aligned with mission. There is a compelling case that a percentage of this capital should be refocused on Social Investment. It is also worth noting that the investment bankers already take 20% of all the revenue we allocate to funding, in Investment Management fees (ie 1% of $1 trillion). As an aside Foundations also ignore their shareholder power.
  3. The Monetization of social externalities with payments based on the delivery of tangible Outcomes (Multi $Trillion). Social Impact Bonds or contingent models offer the opportunity to monetize a much larger market base on out comes. Indeed under this model, higher social return means higher economic return. These surely should attract Mission Related Investment from Foundations.
  4. CSR 2 / Bottom of the Market / Corporate engagement – it is worth noting that capital flows to the developing world are in relative terms one fifth of what they were historically at the turn of the last century. Here you see Impact Investing in its initial stages – the opportunity laid out in the billions by JPMorgan.
  5. Realignment of Government Subsidy – through new innovation to encourage collaboration, replication of solutions and to leverage new civil society distribution mechanisms rather than top down models with their “frictional costs”. These Government to Government costs are measured in the billions. It is worth noting in Sub Saharan Africa historically 80% of aid is estimated to have returned as flight capital in 18 months.
  6. Local Pension Funds ($1.5 trillion – which can be leveraged 15 times over 5 years by innovative guarantee structures). A 1 -2 % market share of such an entity would be bigger than Gates in seven years.

Practically the silver lining in the current financial crisis is the realization that by working together we can create large scale impact and access this capital.

Related Posts:

Arthur Wood – Eleven Global Social Finance Trends

Christian Novak – Social Impact Bonds – Benefits and Promises

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